key term - Increasing Opportunity Cost

Definition

Increasing opportunity cost refers to the concept that as more of a good or service is produced, the opportunity cost of producing an additional unit rises. This principle is closely tied to the topics of absolute and comparative advantage in economics.

5 Must Know Facts For Your Next Test

1. Increasing opportunity cost is a result of the law of diminishing returns, where additional units of a factor of production yield smaller increases in output.
2. As more of a good is produced, resources must be diverted from the production of other goods, leading to a higher opportunity cost per additional unit.
3. Increasing opportunity cost is a key factor in determining a country's or individual's comparative advantage in the production of different goods.
4. The concept of increasing opportunity cost explains why countries or individuals tend to specialize in the production of goods where they have a comparative advantage.
5. Increasing opportunity cost is a fundamental principle that underlies the gains from trade and the benefits of specialization in international trade.

Review Questions

• Explain how the concept of increasing opportunity cost relates to a country's comparative advantage in the production of different goods.
  • As a country produces more of a good, the opportunity cost of producing an additional unit of that good increases. This means the country must forgo the production of other goods to allocate more resources to the good with increasing opportunity cost. The good with the lowest increasing opportunity cost is the one in which the country has a comparative advantage and should specialize in producing, as it can do so at a lower cost than other countries.
• Describe how the principle of increasing opportunity cost leads to the gains from trade between countries.
  • When countries have different opportunity costs for producing goods, they can both benefit from specializing in the goods where they have a comparative advantage and trading with each other. By specializing, each country can produce more of the goods it is best at making, and through trade, they can obtain the other goods they need at a lower cost than if they tried to produce everything themselves. This mutual specialization and trade leads to an overall increase in production and consumption possibilities, resulting in gains from trade for both countries.
• Evaluate how the concept of increasing opportunity cost influences a firm's or individual's decision to allocate resources between the production of different goods.
  • The principle of increasing opportunity cost suggests that as more resources are devoted to the production of one good, the cost of producing an additional unit of that good (in terms of foregone production of other goods) will rise. This means that firms and individuals must carefully consider the opportunity costs involved when deciding how to allocate their limited resources between the production of different goods. They will tend to specialize in the goods where they have the lowest increasing opportunity cost, as this allows them to maximize their output and consumption possibilities. The concept of increasing opportunity cost is therefore a crucial factor in understanding how economic agents make optimal production and consumption decisions.

Related terms

Opportunity Cost:

The value of the next best alternative forgone when making a choice.

Absolute Advantage:

The ability to produce a good using fewer inputs than another producer.

Comparative Advantage:

The ability to produce a good at a lower opportunity cost than another producer.